A hard money loan is a loan that is secured by an asset, usually real estate, and paid off in regular installments. Unlike a traditional mortgage, a hard money loan is a non-conforming loan from a private investor or investment group, not a standard lender like a bank or credit union.
With a hard money loan, the lender will usually look more closely at the strength of the investment than they will at the credit and income of the borrower. This is because hard money loans can't be insured the same way a conventional mortgage can; therefore, they don't have as stringent income requirements. Instead, they usually feature higher interest rates; if you don't pay within the allotted period, they can foreclose on the property.
But because you don't have to go through a stringent underwriting process, you can typically access funds much faster than a regular mortgage. This fast funding means they are suitable for those who need quick cash to purchase a property when the opportunity arises.
As a result, hard money loans tend to be a bit riskier than a standard mortgage. But, they make sense for specific borrowers who may not have the time or credentials to be approved for a conventional loan.
Hard money loans tend to offer a loan-to-value ratio lower than a standard mortgage, which means a larger down payment is usually required. The LTV ratio of a hard money loan is usually around 65% - 75% of the value of the collateral (aka the property). That means they typically require a down payment of anywhere from 10 – 35%, depending on the lender.
Interest rates on a hard money loan can also vary, but they tend to be relatively high. Most hard money loans offer interest rates anywhere from 8 – 15%, depending on the deal. In addition, hard money loans have a higher probability of default due to the laxer lending requirements, so the lender will compensate for it by charging more interest.
The repayment period on a hard money loan is typically between 12 and 36 months, whereas most conventional mortgages offer repayment periods of either 10, 15, or 30 years. But that's because hard money loans are better for short-term real estate investment deals, not home purchases.
Total Interest Paid
Even though you're paying a higher interest rate because the repayment term is much shorter, you'll pay far less in interest over the life of the loan compared to a mortgage. For instance, if you got a $200,000 loan at 10% for 12 months, at the end of the year, you'd pay $20,000 in total interest if everything goes smoothly.
A hard money loan is a specific type of financial product intended for real estate investors, not traditional homebuyers. They are short-term, high-interest loans meant to finance the purchase of the property so the purchaser can either rehab it for sale or rent it out.
They differ from a conventional mortgage in that the government or any government-sponsored entity does not insure them; therefore, they are considered higher-risk loans for lenders and carry higher interest rates.
But they also differ from other unsecured loans, such as personal loans and credit cards. They are a specific type of financial product that is best for those who only need a short-term lump sum of cash and will be able to pay it back quickly.
Flipping a House
Most hard money loans are used to flip houses because it's the scenario where it makes the most sense. House flippers tend to avoid conventional mortgages because they offer more favorable terms for homeowners than investors.
For instance, mortgages often feature repayment penalties if paid off early, which isn't ideal for flippers that want to make a purchase and pay back the loan within a year or two. Plus, it may be harder to prove your income if you're a full-time house flipper. So, a hard money loan can be handy for investors because it offers fast financing without the same intense underwriting process.
Buying an Investment Property
Another scenario where a hard money loan would come in handy is when purchasing an investment property that requires some maintenance. If you can buy it at a discount and then charge higher rents by fixing it up, you could use the rental income to pay off the loan or refinance once the renovations are complete to get a lower interest rate.
Due to the nature of a hard money loan, it isn't the best financial product if you're planning on holding onto the property for more than 2 or 3 years. But if you need a quick injection of cash to finance a purchase and renovation, then plan on selling or refinancing afterward, then this can be a smart strategy.
Starting a Business
If you're starting a business but don't have the credentials to get a standard business loan, then hard money loans can be an option. They will still need some form of collateral, so you will need to use your primary residents or some other asset you own to secure the loan, even if you have good credit. Doing so can be risky, so make sure you are confident you can pay back the loan with interest before you go this route. But a hard money loan is an option if you have a strong business model and need a quick influx of cash to get started.
1. Looser Credit and Income Requirements
One of the major benefits of hard money loans is that they typically feature flexible credit and income requirements. The requirements vary depending on the lender. But many won't even look at your credit and income if the deal is strong, which is useful for investors and others who wouldn't otherwise be approved for a loan.
2. Fast Funding
Another significant benefit of a hard money loan is the quick approval process. Lenders can usually ascertain the value of the collateral reasonably quickly, which means you can typically close on a hard money loan in anywhere from 2 – 14 days, compared to 30 – 45 days for a mortgage.
3. Flexible Terms
Hard money loans also tend to feature more flexible terms than loans from conventional lenders such as banks. Banks and other institutional lenders must adhere to regulations and have standard policies by which they operate. Individuals or private lending groups provide hard money loans, which means they have more leeway to tailor the loan to meet the particular deal.
4. Amount Based On the Value Of the Collateral
Lenders will base your approval amount on the value of your collateral, not your credit score and income. While they won't approve you for 100% of the loan's value, you can expect to get enough to fund the majority of the deal, regardless of your financial situation.
1. High-Interest Rates
The biggest drawback of hard money loans is the high-interest rates. Nothing in life is entirely free, so if you want laxer requirements and faster funding, you will pay for it with more interest. Otherwise, the deal wouldn't make sense for the lender.
2. Interest-Only Period
Be aware that hard money loans often feature an interest-only period or other terms that may not favor the borrower. This means that the payments you make are 100% profit for the lender, and you'll still be required to pay back the entire balance at the end of the loan term. So read the fine print carefully and know what the loan entails before you sign anything.
3. High Down Payment
Hard money loans also typically require a higher down payment than a traditional mortgage to help negate some of the additional risks. You should be prepared to put down between 20% and 30% to be able to get a hard money loan.
4. No Long-Term Options
Most hard money lenders don't offer long-term options because it would be too risky. So be prepared to pay back the loan in 1 – 3 years. That's why this financing isn't the best option for those looking to purchase a primary residence and live in it for an extended period.
Do an Online Search
If you're looking for a hard money lender, you can start with an online search. Google hard money lenders in your area and look at what options come up. Make sure to scrutinize each lender to ensure they are reputable, but this is an excellent place to start. You may also want to check local real estate investing Facebook groups or visit any online real estate-related forums.
Attend Real Estate Investment Events
Another way to connect with hard money lenders is to attend local real estate events. Sometimes lenders will attend these types of events looking for clients. Or you may be able to strike up a conversation with other investors and inquire about where they get financing. If you're apprehensive about dealing with a lender you found online, building relationships with other investors and asking for a recommendation is the way to go.
Ask a Realtor
Another option is to work with a realtor and have them help you find a lender. Realtors often have connections and insight to help find the perfect hard money lender for your situation. But be sure to reach out to a realtor who works with investors because an agent who works primarily with residential homebuyers may be unable to help.
Are Hard Money Loans Tax Deductible?
It depends on how you use the loan and structure your business, but you can sometimes claim tax deductions for expenses associated with hard money loans. For example, interest from a hard money loan is tax deductible if it's a business expense but not a personal expense. So, if you use the loan to purchase an investment property, you can deduct the interest as a business expense, especially if you use an LLC or corporation. But if you use the hard money loan to pay for a personal expense, for instance, if you used it to buy a home because you can't qualify for a conventional mortgage, then it's not tax deductible.
Is it Difficult to Get a Hard Money Loan?
It's not hard to be approved for a hard money loan if you have the collateral and savings for a down payment. The underwriting process is pretty simple, and you can typically be approved or denied within a few days of applying. But you will need to find a real estate deal that appeals to the lender or be willing to use your own property as collateral, which isn't necessarily easy. You will likely need a sizeable down payment, which may take some time to save.
Is Getting a Hard Money Loan a Good Idea?
Hard money loans make sense for a particular type of borrower. They benefit house flippers because they offer favorable terms for that investing strategy. But due to the high-interest rates and short repayment period, they aren't the best product for the typical homebuyer unless you have no other options. So, while hard money loans can be suitable for investors and business owners, they carry certain risks. So, research the lender and read the fine print carefully before agreeing to a hard money loan.